Business Finance

Quarter 3 – Module 6 Week 6: Basic Long-term

Financial Concepts

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 What I Need to Know

This module deals with simple and compound interest. The concepts of simple
and compound interest are explained.

At the end of this module, you are expected to calculate future value and
present value of money (ABM_BF12-IIIg-h-18) by:
a. distinguishing simple and compound interest; and
b. solve exercises and problems in computing for time value of money with
the aid of present and future value tables.

Lesson
Simple and Compound
1 Interest
Businesses and individuals borrow money if in need of cash. When they borrow
money, they incur debt. The lender earns money through interest and the borrower gets
the money he needs but in return, he needs to pay the money he borrowed plus the
interest.

What is the time value of money?

The time value of money (TVM) is the concept that money you have now is worth
more than the identical sum in the future due to its potential earning capacity. This core
principle of finance holds that provided money can earn interest, any amount of money
is worth more the sooner it is received. (Investopedia)

People invest their money to receive returns in the future. The time value concept
helps individuals or businesses to analyze what will be the value of money in the present
and in the future.

The present value is the original amount borrowed, the future value is the principal
plus the total interest earned over a stated period, the interest is the amount of money
paid for the use of borrowed money. Present value and future value are both involved in
the time value of money. Both consider three factors: principal, interest rate, and time.

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 What is It

Simple Interest
Simple interest is computed based on the principal amount (original amount) and
based on the annual time. It is computed by multiplying together the principal, rate, and
time.

I = Prt

Where: I = simple interest

P = principal
r = interest rate
t = time

To find the future value (maturity value) at the end of the term, add the principal
amount and the interest earned.

FV = P + I or FV = P (1+rt)

Example 1: You invested Php 20,000.00 for three years at 5% simple interest rate.
How much will you get after three years?

Solution:

Given: P = Php 20,000.00 r = 5 % or .05 t = 3 years I

= Php 20,000.00 x .05 x 3

= Php 3,000.00

FV = Php 20,000.00 + Php 3,000.00

= Php 23,000.00

Figure 1. Growth Value Using Simple Interest

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 Example 2: Alex paid Php 1,537.50 with a loan made 3 months before at 10%
simple interest. Find the principal amount of the loan and the interest generated.

Solution:

Given: FV = Php 1,537.50 r = 10 % or .1 t = 3 months = 3/12 = .25

F
P =
1+rt
Php 1,537.50
=
1+(.1)(.25)

I = FV - P

= Php 1,537.50 – Php 1,500.00

= Php 1,500.00 = Php 37.50

Example 3: The interest on a loan of Php 20,000.00 is Php 3,200.00. If the rate
is 8%, when is the loan due?

Given: P = Php 20,000.00 r = 8 % or .08 I = Php 3,200.00

I
t =
Pr
Php 3,200.00
=
Php 20,000.00 (.08)
= 2 years

Example 4: Determine the simple interest rate if an investment of Php

25,000.00 accumulates Php 27,625.00 in 18 months.

Given: P = Php 25,000.00 FV = Php 27,625.00 t = 18 months = 1.5 years I

= FV – P
= Php 27,625.00 – Php 25,000.00
= Php 2,625.00
I
r =
Pt
Php 2,625.00
=
Php 25,000.00(1.5)
= .07 or 7 %

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Compound Interest
Compound interest is simply earning interest on interest. It means that the
interest earned is added to the principal, and the new principal draws interests.

FV = P (1 + r) t

Where: FV = future value

P = principal
r = interest rate
t = time

Example 4: You invested Php 20,000.00 for three years at 5% compound

interest rate. How much will you get after three years?

P = Php 20,000.00 r = 5 % or .05 t = 3 years FV

= Php 20,000 (1+.05) 3

= Php 20,000.00 (1.05) 3
= Php 23,152.50

Figure 2 Growth Value Using Compound Interest

Instead of computing the value for (1 + r) t, we can use the Future Value Interest Factor
(FVIF). The values for Future Value Interest Factors are shown in Table 1.1 and Table 1.2.

FV = P x FVIF
= Php 20,000.00 x 1.157625
= Php 23,152.50

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 Example 5: Your father paid Php 176,234.17 with a loan made 5 years ago at 12%
compound interest. What is the principal amount of the loan and the interest
generated?

Solution:

Given: FV = Php 176,234.17 r = 12 % or .12 t = 5 years

P
FV
=
(1+r)𝑡𝑡
𝑃𝑃ℎ𝑝𝑝 176,234.17
=
(1+.12)5
= Php 100,000.00
1
Instead of computing the value for
(1+𝑟𝑟)𝑡𝑡

we can use the Present Value Interest

Factor (PVIF). The values for future value interest factors are shown in Table 2.1 and Table
2.2.

P = FV x PVIF

= Php 176,234.17 x 0.567427

= Php 100,000.03

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 Compounding frequency is the number of times an interest is computed on a certain
principal in one year. The conversion period per year could be annually,
semi-annually, quarterly, or monthly. The equation is j = 𝑖𝑖 .
𝑚𝑚

Where: j = nominal rate

i = interest rate
m = frequency of conversion

Total number of conversion periods n

n = tm = (frequency of conversion) x (time in years) To

find the maturity value, the equation is F = P (1+j) n

No. of Interest Rate per Period

Compounding Frequency Compounding
% decimal
Periods
10
10 % compounded annually 1 = 10 .1
1
10
10 % compounded semi-annually 2 =5 .05
2
10
10% compounded quarterly 4 = 2.5 .025
4
10
10 % compounded monthly 12 = .83 .0083
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Table 3. Example of Nominal Rates

Example 5: Find the maturity value and interest if Php 15,000.00 is deposited in a bank
at 3% interest compounded quarterly for five years.

P = Php 15,000.00 r = 12 % or .12 t = 5 years m = 4

i
j= m
12
= = 3% 𝑜𝑜𝑜𝑜 .03
4
n = mt = (4)(5) = 20

Using the PVIF

FV = P (1+j) n FV = P x FVIF
= Php 15,000.00 (1+.03)20 = Php 15, 000.00 x 1.806111
= Php 27,091.67 = Php 27,091.67
= Php 27,091.67 - Php 15,000.00
= Php 2,091.67

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Simple Interest versus Compound Interest
Simple interest is the interest paid on the initial principal only, while compound interest
is the interest paid on both the principal and the amount of interest accumulated in prior
periods.
Using the previous example, let us compare simple and compound interest. What
did you notice with the principal amount and the interest amount? In simple interest, the
interest is earned on the initial principal only, but in compound interest, the interest is
earned on both the principal and the amount of interest accumulated in previous periods.

Simple interest Compound interest

Interest Interest
Year Principal Future Value Principal Future Value
P x .05 P x .05
1 Php 20,000.00 Php 1,000.00 Php 10,500.00 Php 20,000.00 Php 1,000.00 Php 21,000.00
2 Php 20,000.00 Php 1,000.00 Php 11,000.00 Php 21,000.00 Php 1,050.00 Php 22,050.00
3 Php 20,000.00 Php 1,000.00 Php 11,500.00 Php 22,050.00 Php 1,102.50 Php 23,152.50
TOTAL: TOTAL:
Php 3,000.00 Php 3,152.50
Table 4. Simple Interest versus Compound Interest

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 What’s More

Directions: Answer the following questions. Write your answers on a separate sheet of
paper.

Activity 1
Compute the following using a simple interest assumption:
1. Liza borrowed Php 18,000.00 at 11% interest for 3 years. How much money did
she have to pay?
2. Mario borrowed from his friend Php 15,000.00 to buy a new laptop. His friend
charged 5% for the borrowed amount payable after two years. How much will be
the interest and the future value?

Activity 2
Using the situations provided in Activity 1, compute each scenario using
compound interest assumptions.

Activity 3
Compute for the present value of the following using the present value interest factor
1. Karen is expecting to get Php 500,000.00 in 10 years after depositing her
savings in a time deposit account with 2% interest per annum.
2. Maria obtained a housing loan payable in 5 years at a total amount of Php
1,000,000.00 with an annual interest rate of 7%.

What I Can Do

Directions: Solve the problem. Write your answers on a separate sheet of paper. (10
points)

You want to invest your savings worth Php 7,000.00 for the next 5 years. Bank A
offers simple interest at a rate of 6%. Bank B offers a compound interest rate of 6% yearly.
Which bank are you going to invest your money with? Write your solutions.

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